Retiring with real estate while managing risk

Published by Mitch Provost on

Traditionally, we have been taught that saving for a rainy day is the way to retirement with the objective of saving as much money as you can so that you can live from the interest. The big question is ‘how much is enough’? I remember the Fidelity commercials where everyone was walking around with a number (a really big number) floating above their head. Using strategic investing and projecting returns on those investments, you could theoretically earn enough interest to cover your expenses and your principle would remain the same, giving you an indefinite supply of cash.

Most of us are concerned with this theory and those of us approaching our desired retirement age have our doubts, mainly because we really don’t have control over how much interest a market place investment (stocks/bonds/mutual funds/commodities/etc) will earn. Sure, there is a lot of statistical data to help choose the investment with the best chance of high returns, but no one can really predict how well the market will perform, especially the specific stocks that we own. Our real need is cash flow that we have direct control over and statistically beats the risk of the market place.

Cash flow at retirement is either positive, break-even or negative. Anyone with positive cash flow is in good shape since their principle is actually growing, creating more earning power. As long as it stays positive, there is a possibility for exponential growth. Most of us would be happy with break-even cash flow, knowing that our principle is preserved and we can live life without worrying about money. The problem is that we all seem to have experienced an unplanned or unpredictable expense that could dip into our principle if we were living at break-even. This could potentially upset the delicate break-even balance and start a downward course with negative cash flow.

In fact, many retirees have planned that they will simply spend all of their principal until they run out of money on the last day of their lives. The obvious problem is no one can predict when that day will be – what happens when you run out but still have some years to go? This is what usually either motivates us or gives us extreme anxiety. I think most of us suffer the latter.

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Real estate investing provides an opportunity to have control over cash flow if the risks are mitigated properly. We can’t predict if a tenant will have problems paying rent or if something mechanical will break down or if property taxes will increase, etc, but we can develop mitigation action plans to address each one of these that will minimize, or in some cases eliminate, the risk. This gives us control over the outcome and is one of the primary differences between open market investing and private real estate investing.

Apartments are commonly too large for any single person (ultra high net worth excluded) to wholly own. Deal sponsors will syndicate for private funding of the equity in the Apartment property and leverage the remaining with a loan. This provides the opportunity for passive investors to still have the benefits of real estate investment ownership (tax benefits included) without the direct management demands. This requires trust in the sponsor that he will fulfill the role of addressing the risks that could spoil the investment, but relieves the investor from taking it into his own hands. Through the deal sponsor, the passive investor still has direct control over their investment and a far better opportunity to maintain that positive cash flow position.

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How much risk is in your retirement savings plan?

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2 Comments

Luis · May 1, 2018 at 9:29 am

I have always liked the idea of owning apartments as a side investment, but it almost seems an impossible option due to the magnitude of the investment required to make it work, both in money and time. After some thought on the options, I came to the conclusion that buying multiple town homes in a closed community would have a similar positive effect while avoiding the headaches of building from scratch. Having a management company already established and a stable community helps minimize risks at a low cost.

Mitch Provost · May 1, 2018 at 9:50 am

Luis,
I had the same thoughts as you going into apartment investing, but then realized that I was investing as much money into individual single family homes as I could in an apartment deal. As a passive investor, the transaction was very simple and completely hands off. Even though I am one of several other limited partners, I’ve been enjoying monthly cash flow from that deal without any involvement. Additionally, the deal sponsor is using equity to upgrade the property and raise rents to increase NOI. This will result in much higher value when it comes time to sell. The regular cash flow and forced appreciation is the reason I invested passively into apartment deals rather than continue to purchase smaller properties.

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